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Why you should not invest in sector funds? - Outside View by PersonalFN

The pink papers as well as business channels often paint some picture or another on various sectors - be it infrastructure, auto, oil & gas, FMCG, Pharma, etc. Various sector analysts along with some industry professionals too, do provide their views thus making the story look more appealing - both in a positive way as well as in a negative way. And since these media reports are often read by many, the sector indices display a "see-saw" movement.

Let us take you back in time. In the year 2007 when the equity markets were buzzing the real estate markets too went crazy taking prices beyond the reach of the common man. The pink papers made the whole infrastructure theme look bold by flashing headlines like - "Infrastructure sector will be a key contributor to our economic growth". But as news of U.S. sub-prime mortgage crisis emerged in January 2008, ripples were sent to across various developed and emerging nations including India, and the much boasted about infrastructure theme / sector lost its steam. Several infrastructure companies which had leveraged their balance sheets suffered in pain, since sales dropped and stiff interest cost on borrowed funds started biting into their profits. Taking into account these economic equations, stocks in the infrastructure theme / sector too were battered, and when Lehman Brothers (once one of world's largest bank) went bust (in September 2008) the severity escalated. Later due to capital goods, Lehman Brothers news, even the Indian financial system - banking stocks were negatively impacted. But fortunately since our central bank - the Reserve Bank of India was prudent enough in not to adopt exuberant policy stance, the impact of global economic negativity was better controlled.

Now while you may say - "it was a one-off global event and the impact of it was on mainly two sectors", we beg to differ with you on that, because the crippling effect of the same was also seen in other sectors as well - be it FMCG, capital goods, media & entertainment, retail and many more. This is because several people had lost jobs which negatively impacted the consumption story, and inflation too was stiff for good seven months (i.e April 2008 to October 2008). For companies too it was a tough time as their capex plans were derailed, and as a nation summing-up all these we witnessed recession for good six months (since the Lehman Brothers bankruptcy).

So, we suffered the pain for almost 13 months before we started a bull phase. We experienced a "see-saw" movement, which brought several investors wealth and health to risk. And especially those who betted on sector funds heavily promoted and those newly launched in 2007 (especially energy & power funds and infrastructure funds), they still haven't been able to create wealth for their investors.

How various sector funds have fared?

Scheme Name

6-Mth (%)

1-Yr (%)

2-Yr (%)

3-Yr (%)

5-Yr (%)

Since Inception (%)

Std. Dev (%)

Sharpe Ratio

Portfolio Turnover Ratio (%)

Expense Ratio (%)

BANKING & FINANCIAL SERVICES FUNDS

Reliance Banking (G)

-14.8

19.5

28.7

20.1

26.4

33.3

10.97

0.16

44.00

1.93

UTI Banking Sector (G)

-13.8

16.1

24.8

14.6

21.9

27.5

10.61

0.13

271.41

2.34

ICICI Pru Banking & Fin Serv (G)

-12.5

15.6

24.2

-

-

22.8

9.85

0.19

53.00

2.40

Religare Banking (G)

-13.7

15.4

27.7

-

-

26.0

9.66

0.20

224.00

2.50

Category Average*

-13.7

16.7

26.4

17.4

24.2

27.4

10.27

0.17

-

-

BSE BANKEX

-11.9

16.7

22.0

10.5

19.3

-

12.85

0.10

-

-

ENERGY & POWER FUNDS

Reliance Diver Power Sector (G)

-19.1

-11.8

8.4

0.4

19.9

31.2

9.43

0.01

25.00

1.82

UTI Energy (G)

-10.5

-4.3

9.2

-3.1

-

-8.7

8.73

-0.03

21.09

1.64

Sundaram Energy Opportunities (G)

-12.1

-3.6

6.0

-4.0

-

-7.9

10.27

-0.02

133.00

1.94

Category Average*

-13.9

-6.6

7.9

-2.2

19.9

4.9

9.48

-0.01

-

-

BSE POWER

-14.1

-13.6

-2.7

-8.4

7.9

-

10.94

-0.06

-

-

FMCG FUNDS

Franklin FMCG (G)

0.2

24.5

39.9

19.6

14.4

17.2

5.91

0.20

6.04

2.08

ICICI Pru FMCG (G)

4.8

31.7

42.2

12.1

12.4

17.2

7.15

0.10

36.00

2.49

SBI Magnum FMCG

3.8

30.0

47.3

22.5

16.4

12.2

5.99

0.24

42.00

2.50

Category Average*

3.0

28.7

43.1

18.1

14.4

15.5

6.35

0.18

-

-

BSE FMCG

5.5

33.7

34.0

14.7

13.5

-

6.25

0.13

-

-

INFRASTRUCTURE FUNDS

HDFC Infrastructure (G)

-14.8

0.8

19.4

4.9

3.4

10.37

0.06

38.30

1.97

Birla SL Infrastructure (G)

-15.7

-3.5

12.1

1.3

9.3

8.9

10.61

0.02

51.00

2.26

ICICI Pru Infrastructure (G)

-9.9

2.1

8.8

-0.8

14.3

19.8

8.96

-0.01

93.00

1.85

Tata Infrastructure (G)

-16.0

-2.4

8.5

-3.1

9.4

19.3

9.83

-0.02

30.42

1.91

UTI Infrastructure (G)

-15.0

-7.0

3.2

-5.2

5.9

17.2

8.71

-0.06

133.16

1.80

Category Average*

-14.3

-2.0

10.4

-0.6

9.7

13.7

9.7

0.0

-

-

BSE-200

-9.8

7.1

15.2

1.2

10.7

-

10.20

0.02

-

-

PHARMA FUNDS

Reliance Pharma (G)

-2.4

13.0

57.4

31.1

24.1

27.9

8.15

0.27

29.00

2.23

Franklin Pharma (G)

-2.8

15.4

53.3

28.3

18.1

16.4

6.80

0.29

8.74

2.06

UTI Pharma & Healthcare (G)

-4.7

16.5

40.0

18.5

12.8

26.9

6.13

0.20

65.68

2.09

SBI Magnum Pharma (G)

-3.8

14.5

43.5

10.2

4.1

11.5

9.40

0.10

79.00

2.50

Category Average*

-3.4

14.8

48.6

22.0

14.8

20.7

7.62

0.21

-

-

BSE HEALTH CARE

-7.2

15.7

36.8

12.2

11.7

-

7.41

0.11

-

-

IT FUNDS

Franklin Infotech(G)

1.0

19.7

45.4

13.0

10.5

22.1

8.62

0.13

1.26

2.43

ICICI Pru Technology(G)

0.1

27.4

53.0

8.5

10.1

5.4

9.50

0.09

17.00

2.46

DSPBR Technology.com(G)

-4.0

1.0

32.5

3.1

13.6

11.1

9.00

0.03

80.00

2.50

SBI Magnum IT

1.2

16.9

42.7

3.0

6.3

9.6

10.62

0.05

31.00

2.50

Category Average*

-0.4

16.3

43.4

6.9

10.1

12.1

9.44

0.07

-

-

BSE IT

2.2

18.4

45.3

10.4

10.0

-

9.07

0.11

-

-

MEDIA & ENTERTAINMENT FUNDS

Reliance Media & Entertainment (G)

-15.3

-1.2

20.1

-3.4

6.5

15.6

10.83

-0.01

42.00

2.50

Sundaram Enter Oppor (G)

-7.5

-2.0

9.7

-

-

12.6

8.58

0.10

8.00

2.50

Category Average*

-11.4

-1.6

14.9

-3.4

6.5

14.1

9.7

0.0

-

-

BSE SENSEX

-7.7

10.2

12.5

1.2

10.6

9.66

0.02

-

>-

NAV data is as on May 18, 2011. Standard Deviation and Sharpe ratio is calculated over a 3-Yr period. Risk-free rate is assumed to be 6.37%)
*Category average has been calculated taking into account the peers above
For Media & Entertainment Funds benchmark returns and ratios are not provided due to unavailability of data
(Source: ACE MF, PersonalFN Research)

In fact the table above makes it evident that, investors especially those in the energy & power sector funds haven't been able to generate wealth over a 3-Yr time frame, and even since inception. Barring Reliance Diversified Power Sector Fund, most power & energy sector funds have eroded wealth for investors.

Similarly, even infra funds which were promoted in great gusto when the equity markets were booming in 2006 and 2007 too failed to deliver appealing returns when assessed over a 3-Yr time frame. In fact they have given quite scornful returns to investors.

However, the Banking & Financial Service Sector Funds managed to deliver luring returns over a 3-Yr time frame (and even since inception) due to prudent policy measures taken by the RBI, to scuffle the impact of global meltdown - especially the Lehman Brother's bankruptcy on the Indian economy. Similarly pharma as a sector being defensive in nature, pharma funds too delivered appealing returns for investors and that too without having exposure to very high risk (as revealed by their Standard Deviation). But FMCG funds despite luring returns generated by them, faltered when India consumption was hurt during the recessionary times of 2008 and early 2009.

Even when we analyse through a study of performance across market cycles, you'll recognise that most sector funds - especially those in the energy & power space and infra space, accelerated well on the return front during the bull phase prior to the emergence of U.S. sub-prime mortgage crisis. But, when the sub-prime crisis emerged in U.S., and shivers of the same were felt in the Indian markets too they took a greater beating. In the present bull rally also they are faltering on the returns front due to host of problems faced by companies in the infra space.

Similarly, for banking & financial services sector funds too the scenario was no different. However, since pharma being a defensive sector while it didn't experience an up-move during the bull phase prior to the emergence of U.S. sub-prime mortgage crisis, refrained from showing a magnanimous fall during the global economic turmoil of 2008 and early 2009. But post the global economic turmoil; pharma funds accelerated wealth creation for their investors.

Hence broadly if you assess, you'll recognise that most sector funds have a tendency to gain more during the upswing of the equity markets (luring you investors!), and similarly don't shy away from disappointing you during the downswing of the equity markets by plunging more as compared to diversified equity funds.

Hence it is vital for you not get swayed by swanky sector reports published by pink papers or broadcasted by glamorous business channels. While they are doing their job of increasing their TRPs (Total Rating Points), it is critical for you to do your job as well of taking prudent investment decisions. Also while your mutual fund distributor / agent / relationship manager may say - "Having sector funds is like adding salt and pepper to your portfolio"; we believe that you got to recognise that the same "salt and pepper" can be added to your portfolio through diversified equity funds, as they are free to invest in various sectors / themes as well (when they look promising) and exit from them as the story fizzles out. In fact if you want to take advantage of various opportunities in respective sectors we recommend that you look at some good "opportunities style" diversified equity funds, which follow strong investment systems and processes.

Moreover, since diversified equity funds truly undertake diversification strategy for you in its true senses (as they hold stocks from various sectors / themes); they provide you better safety as the specific exposure to a sector / theme is reduced. While investing in diversified equity funds, we opine that investors should have a long-term horizon and adopt the SIP (Systematic Investment Plan) route of investing as it would provide you the advantage of rupee-cost averaging along with compounding.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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Ethical practices help build long lasting relationships, and healthy long-term business relationships are often mutually rewarding. But PersonalFN is of the view that the financial services industry in India seems to have forgotten this.